Chris Davis’ Davis New York Venture Fund Annual Review 2015

Summary

For the most recent 1, 5, 10, and 20 year periods, Davis New York Venture Fund built shareholder wealth. Over these periods, a $10,000 investment grew to $10,655, $17,253, $18,277, and $70,333, respectively.

Since inception in 1969, a $10,000 investment in the Fund has increased to more than twice the value of the S&P 500® Index: $1.7 million vs. $821,000.

Portfolio holdings driving shareholder returns in the coming years include: companies with outstanding competitive advantages; companies involved in significant capacity expansion projects or transformative mergers; businesses undervalued due to distortions caused by GAAP; and beneficiaries of continued health care expansion.

We have avoided areas of the market that we believe are overvalued and riskier than they appear and that do not offer investors sustainable, long-term wealth-building opportunities.

The Davis family, employees and directors are the largest shareholders in the Fund.

The average annual total returns for Davis New York Venture Fund’s Class A shares for periods ending December 31, 2014, including a maximum 4.75% sales charge, are: 1 year, 1.49%; 5 years, 10.44%; and 10 years, 5.70%. The performance presented represents past performance and is not a guarantee of future results. Total return assumes reinvestment of dividends and capital gain distributions. Investment return and principal value will vary so that, when redeemed, an investor’s shares may be worth more or less than their original cost. The total annual operating expense ratio for Class A shares as of the most recent prospectus was 0.86%. The total annual operating expense ratio may vary in future years. Returns and expenses for other classes of shares will vary. Current performance may be higher or lower than the performance quoted. For most recent month-end performance, click here or call 800-279-0279.

We launched Davis New York Venture Fund more than four decades ago based on the principle that investing in well-researched, durable businesses is the best way to build wealth over the long term. Since then, we have grown the value of an initial $10,000 investment to more than $1.7 million today, a 170-fold increase.2 While at times this rate of growth has been faster or slower, our steadfast focus on equities combined with an investment discipline centered on research, careful stock selection and a long-term perspective have helped us increase the value of our clients’ savings. In fact, as the chart below shows, the longer clients remained with us, the more we increased their savings.

This consistent, long-term record of satisfactory absolute returns reflects the wealth-creating potential of owning a portfolio of carefully selected businesses through all types of economic and market environments.

In addition to generating satisfactory absolute returns, our investment approach has delivered relative returns in excess of the S&P 500® Index over the long term. For example, the same $10,000 investment we grew to $1.7 million in Davis New York Venture Fund since its inception would have grown to only about $821,000 invested in the S&P 500® Index over the same period of time.2 The fact a shareholder who invested with us at our inception would now have more than twice the savings of an individual who chose to invest in a passive index reflects the value we have added through careful research and active management over the long term.2

Importantly, these strong long-term results include a handful of periods along the way when our investment approach of seeking durable, well-managed businesses at attractive prices was not rewarded by the market.

This report includes candid statements and observations regarding investment strategies, individual securities, and economic and market conditions; however, there is no guarantee that these statements, opinions or forecasts will prove to be correct. Equity markets are volatile and an investor may lose money. Past performance is not a guarantee of future results. 1Class A shares without a sales charge. Past performance is not a guarantee of future results. 2Class A shares without a sales charge. Past performance is not a guarantee of future results. Inception date is February 17, 1969. 3Performance is of a hypothetical $10,000 investment in Davis New York Venture Fund Class A shares without a sales charge. Returns for other classes of shares will vary. All returns include the reinvestment of dividends and capital gain distributions. Investments cannot be made in an index.

Our investment discipline has built wealth for shareholders for more than 45 years.

As active managers, we know we will go through periods when our results trail the market, particularly when indexing and other momentum-based strategies are galloping ahead. We have been through such times before and have always emerged in a strong position. For example, in the late 1990s the S&P 500® Index surged ahead and disciplined value investors like us were considered dinosaurs. But when the bubble burst in 2000, many of these dinosaurs posted the best relative results of their careers. Davis New York Venture Fund, for example, outperformed the Index by 19% in 2000 and also outperformed over the next 1, 3, 5, and 10 year stretches.4 While we do not know when the current cycle will end, we are confident the investment discipline that has helped our shareholders build wealth for more than 45 years will continue to do so. Our conviction in our discipline is strengthened when results are viewed on a rolling basis rather than a trailing basis. The chart below divides our results into rolling periods ranging from one to 45 years with the bars indicating the percentage of those periods our returns exceeded the benchmark. As with our absolute returns, the longer clients remained with us the better the relative outcome.

Chris Davis’ Davis New York Venture Fund: Near-Term Results

We have avoided areas of the market that we believe are overvalued and riskier than they appear and that do not offer investors sustainable, long-term wealth-building opportunities.

The rolling data above combined with our long record of satisfactory absolute returns is a testament to the ability of our research-driven, stock-specific approach to add value over time.

However, delving into what has worked and not worked in the recent periods when our absolute returns have been good but our relative results have trailed is worthwhile.

In the plus column, the strong performance of a number of our core holdings such as American Express, Wells Fargo, Berkshire Hathaway, Costco, and Google have made them significant contributors to our returns over the last several years.5 Moreover, during this period, we believe the competitive advantages of these first-class businesses have only increased, further improving their future prospects.

In the negative column, our relative results have been affected most by our decision to avoid a number of companies and sectors that have done especially well, but that we believe do not offer investors sustainable long-term opportunities. In other words, we have been hurt more by what we chose not to own than by what we owned. For example, while companies with high current dividend yields are currently in fashion, we have avoided or sold most of these stocks because of their below-average growth rates and above-average valuations. Similarly, we have generally steered clear of companies with high leverage ratios that benefit from current low interest rates but risk significant problems if the environment changes. We have also chosen to underweight some of the largest companies in the S&P 500® Index despite the fact these companies currently benefit from the flow of funds into exchange-traded funds and S&P 500® Index funds because their already enormous size may make future growth more difficult. Finally, we do not own a number of companies that are current market darlings because we question their long-term durability and competitive advantages.

Our decision to avoid these companies rests on our experience, judgment and analysis, all of which indicate they are either overvalued or riskier than they appear. As has occurred historically, we believe the relative drag experienced by not owning such companies will reverse in the years ahead.

5 Individual securities are discussed in this piece. While we believe we have a reasonable basis for our appraisals and we have confidence in our opinions, actual results may differ materially from those we anticipate. The return of a security to the Fund will vary based on weighting and timing of purchase. This is not a recommendation to buy, sell or hold any specific security. Past performance is not a guarantee of future results.

Chris Davis’ Davis New York Venture Fund: The Portfolio

Five portfolio themes should drive shareholder returns in the years ahead.

While we build the Portfolio one company at a time based on thorough research and analysis of each underlying business, we have identified five general themes that should drive shareholder returns in the years ahead. First and foremost, at the core of the Portfolio we hold companies whose long-term returns will be driven by the fundamental competitive advantages that each has built over time. For example, leaders like Costco, Amazon, CarMax, Texas Instruments, PACCAR, and Ecolab have significant cost and scale advantages that should produce earnings growth for years, if not decades, to come. Perhaps more important, the competitive advantages of each of these companies have been enhanced by a culture of disciplined capital allocation and high reinvestment rates on retained capital. Whether looking at the returns generated when Costco and CarMax open new stores, PACCAR and Texas Instruments expand their manufacturing operations, Amazon invests in new growth areas, or Ecolab, Berkshire Hathaway and Markel pursue targeted acquisitions, each of these companies has generated more than a dollar of market value for each dollar the business retained. While the short-term stock performance of companies such as these may be driven by the vagaries of market sentiment, their long-term returns will be driven by the growth and durability of their underlying business. Put simply, we feel that these businesses possess the qualities of long-term compounding machines.

Second, we own a number of companies that are involved in transformative mergers or significant capacity expansion projects that should improve future long-term value although they diminish near-term results. For example, Sysco, Lafarge, Liberty Global, and Halliburton have each announced mergers that combine two of the largest companies in their respective industries. Rather than just overhyped synergies, such mergers tend to transform an industry, leading to both cost savings and improved pricing. After such transactions are announced but before they close, the companies’ shares can languish with uncertainty providing the opportunity to buy them before the benefits are clear to others. We expect these mergers to be completed and result in highly satisfactory earnings growth in the years ahead. Similarly, we own several companies that have undertaken significant capital spending projects that should improve long-term value but diminish short-term results. Holdings such as OCI N.V. and Las Vegas Sands are nearing the end of such expansion programs and are likely to benefit as new earning assets are brought online.

Third, the already strong returns at a number of our most important financial holdings should be enhanced as a number of current headwinds gradually reverse in the years ahead. For example, changes in the regulatory environment following the financial crisis required profitable industry leaders like Bank of New York Mellon, JPMorgan and Wells Fargo to build significant capital reserves, which limited their ability to further reinvest for growth, repurchase shares or substantially increase dividends. All of these companies are now unambiguously well capitalized and therefore face the happy prospect of increasing returns to shareholders. In addition, the already robust earnings of these holdings and others such as Charles Schwab are poised to benefit further should interest rates normalize.

Fourth, the number of investors making decisions based on rigid, computer-screening programs has surged. This approach suffers from several fundamental problems, the most important of which is the data is historical and not forward looking. As Warren Buffett said, “If merely looking up past financial data would tell you what the future holds, the Forbes 400 would consist of librarians.” At a time when more decisions are based on computer systems and screening methodologies, companies with GAAP (generally accepted accounting principles) anomalies can be significantly mispriced, creating attractive investment opportunities. For example, the financial statements of holdings like Express Scripts, Julius Baer, Valeant, and Liberty Global all include significant noncash charges that distort their true earnings power. These distortions (and others like them) allow us to own industry-leading growth companies at attractive valuations. We expect the true cash earnings of such companies to drive their returns over time, although we cannot predict exactly when or if they will be rewarded by the market.

Finally, we own a number of leading health care companies whose stock prices may have been affected by the uncertainties surrounding the roll out of ObamaCare. As the dust settles, investors should come to realize that companies such as UnitedHealth Group and LabCorp have not only adapted but are actually thriving in the new environment. The removal of this ambiguity should lead to improved valuations going forward.

Taking these themes together, we believe our Portfolio is in a strong position to grow shareholder savings. The Portfolio is filled with familiar and durable companies, many of which are household names, but looks nothing like the S&P 500® Index. In fact, only four of our top 25 holdings are among the top 25 companies included in the S&P 500® Index. This positioning provides a useful reminder we are true active managers, willing to own companies whose prospects are bright even if their stocks are not currently in favor. As a result, we occasionally think of the Portfolio as a garden. While part of the Portfolio is always blooming, we are also constantly planting seeds that will come to fruition in a different season. Knowing the companies we own, we are convinced the returns we have not earned today will be earned in future years.

Chris Davis’ Davis New York Venture Fund: Our Core Principles

Every Davis Fund has grown shareholder wealth, has below-average expenses and Davis is the largest shareholder.

As stewards of our clients’ savings, our overarching responsibility is to increase the value of the assets entrusted to our care. To do so, we steadfastly focus on equities. While Davis New York Venture Fund and the other six equity Davis funds we oversee each have a different area of focus, all share the same fundamental investment philosophy. This philosophy combines experience, research rigor, a willingness to be different, patience, and a long-term perspective. Furthermore, every one of these funds has grown shareholder wealth and has below-average expenses.6

Our focus on stewardship and performance is sharpened by our belief that managers should invest their own money alongside their shareholders. Doing so helps ensure shareholders’ interest is a primary focus. At Davis Advisors, we are owner operators and are the largest shareholders in each of our funds, with more than $2 billion of our own money alongside our clients.7 The alignment of interests that comes from co-investment is central to our culture and rarer in the industry than we would have imagined. In fact, of the 7,700 funds tracked by Morningstar, nearly half are run by managers who do not have a single penny in their own funds and only 12% are run by managers who have more than $1 million invested alongside their shareholders.8 Because of our belief in the power of incentives and the alignment of interests, we do not own a single investment on behalf of our clients in which company management has less than a million dollars invested alongside shareholders. We do not know why investment firms should be any different.

While each of our funds has at times experienced periods of underperformance, the fact all of them have grown shareholder wealth over the long term is a testament to our investment discipline and the principles by which we manage our Firm.

6This is not a solicitation for any other Davis fund, each of which is sold under separate prospectuses. 7As of December 31, 2014. 8Sara Max, “Fund Managers Who Invest Elsewhere,” Barron’s, July 12, 2014.

“The only function of economic forecasting is to make astrology look respectable.”

In managing portfolios, we apply certain time-tested insights that should serve clients well. At the top of this list is to avoid attempting to predict the unpredictable. Whether considering short-term changes in interest rates, stock prices or macroeconomic data, overwhelming evidence suggests such forecasts are futile. As John Kenneth Galbraith famously said, “The only function of economic forecasting is to make astrology look respectable.” Recognizing that a picture is worth a thousand words, the chart below shows the average prediction of Wall Street’s top strategists in orange and the actual market return in green. Put simply, the lines are uncorrelated.

The second insight is to try to be neither optimistic nor pessimistic but rather realistic. Too often, investors only look for data that confirms their existing biases. The pessimists highlight how far the market has come from its lows, the instability of the geopolitical environment, the folly of Washington, problematic unemployment and record high profit margins. The optimists point to improving economic conditions, strengthening balance sheets, economic and market resiliency, and the attractiveness of equities in contrast to other major assets classes. Investors with a rational approach must incorporate the truths in both these views and invest accordingly. This requires the patience and resolve to withstand inevitable setbacks and the conviction and confidence to invest in an inherently uncertain world.

The third important insight is to recognize the potentially destructive costs of irrational investor behavior. Whether by trying to time the market, chasing what has already gone up in price, abandoning investment plans or automatically avoiding out-of-favor areas without due thought, investors are often their own worst enemy. In most cases, the best antidote to these destructive behaviors is to work with a trusted financial advisor who can help craft and maintain a systematic investment plan, look beyond daily market volatility and is willing to examine investment opportunities that are currently out of favor.

Conclusion

At Davis Advisors, we are committed to helping our clients achieve their goals by growing the value of the savings entrusted to our care. We are mindful of our responsibility and grateful for the trust you have placed in us.

I would like to end by recognizing and thanking my colleagues. Each day, I am lucky enough to come to work with a group of individuals who combine intelligence, integrity, diligence, stewardship, and humility. Among this wonderful group, my partner Danton Goei has served as an exemplar for more than 16 years and I would particularly like to thank him.